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9054 results in Finance and accountancy

Page 156 of 453

  • 5 - The Level of Interest Rates

  • from Part II - The Financial System Component of the Financial and Monetary Regime
  • Thomas F. Cargill, University of Nevada, Reno
  • Book:
    The Financial System, Financial Regulation and Central Bank Policy
    Published online:
    06 August 2018
    Print publication:
    06 October 2017, pp 92-114

  • Summary

    Introduction

    The previous chapter laid out the basic concepts needed to understand the determinants of the level of the interest rate. This chapter focuses on what determines the level of interest rates at any point in time, why interest rates increase and decrease over time, how interest rates respond to changes in monetary policy and whether interest rates are a reliable indicator of the intentions of the central bank. The next chapter focuses on the structure of interest rates.

    In this chapter, we focus on the determinants of interest rates in direct financial markets, such as interest rates on Treasury securities, commercial paper, corporate bonds and municipal bonds, as opposed to interest rates in intermediation finance. There are three reasons for focusing only on interest rates in the direct financial markets.

    First, interest rates in the money and capitalmarkets are market-determined; that is, they are determined by market forces, respond quickly to market forces and are not subject to any administrative decision. Second, interest rates in the money and capital markets are the foundation for interest rates in the intermediation financial markets because they reflect all of the important market forces that determine interest rates; that is, when loan and deposit rates are administratively adjusted, the adjustment is in response to changes in the money and capital market interest rates. Third, interest rates in the money and capital markets reflect the cost of borrowing and return from lending without considering intermediation costs; that is, there is little difference between the ask and bid price or interest rate of a bond. In contrast, there is considerable difference between the rate of interest charged by a depository institution for a loan and the interest rate paid on deposits that represent the costs of intermediation. Another way to make the same point is to consider interest rates in money and capital markets as representing the equilibrium cost of funds determined by the coming together of a large number of well-informed borrowers and lenders in a competitive environment that comes very close to the model of perfect competition presented in introductory microeconomics. The only intermediary is a broker or agent, who assists in bringing together the lender and the borrower but who takes no risk position; that is, the broker or agent collects a fee and disappears.

  • 10 - A Short History of the U.S. Financial and Monetary Regime in Transition

  • from Part III - The Role of Government in the Financial and Monetary Regime
  • Thomas F. Cargill, University of Nevada, Reno
  • Book:
    The Financial System, Financial Regulation and Central Bank Policy
    Published online:
    06 August 2018
    Print publication:
    06 October 2017, pp 206-230

  • Summary

    Introduction

    It is important to understand the historical evolution of the nation's financial and monetary regime for three reasons.

    First, one cannot consider oneself educated in financial andmonetary issues – or, for that matter, general economic issues – unless one has some basic understanding of the historical evolution of the nation's financial and monetary regime.

    Second, a historical perspective provides lessons for how best to design a financial system, government regulation and supervision and central bank policy. The often quoted philosopher George Santayana emphasized the importance of historical perspective in this regard: “Thosewho cannot remember the past are condemned to repeat it.” Much has been learned from the past, but sometimes there is a sense of déjà vu in that government regulation and supervision and central bank policy fail to learn from the mistakes of past policy decisions.

    Third, the historical evolution of the financial and monetary regime provides insights intomajor economic problems experienced by theUnited States, especially the three periods of intense economic and financial distress – the Great Depression, the Great Inflation and the Great Recession. These three periods provided the catalyst for major institutional redesigns of the nation's financial and monetary regime andmanifested the interplay between government policy failure andmarket failure. It is important to have a balanced view of the causes of major periods of economic and financial distress and far too convenient to simply attribute them to market failure, as is the common practice. An intellectually balanced approach requires that both market and government failure be considered, but, since government policy makers often set the regulatory parameters and have greater access to the pulpit, the public gets an unbalanced view. Fourth, an understanding of the interplay between government policy and market behavior helps us understand the broader debate about the role of government in the nation's economy and whether we have cometo expect too much from government regulation and supervision, fiscal policy and monetary policy. Much of the education system provides a one-sided view of the role of government in the economic and monetary affairs of the U.S. economy. Not only does it emphasize market failure over government policy failure but it presents an unrealistic view of the ability of government to solve economic and financial problems.

  • 3 - The Financial System and the Country's Flow of Funds

  • from Part II - The Financial System Component of the Financial and Monetary Regime
  • Thomas F. Cargill, University of Nevada, Reno
  • Book:
    The Financial System, Financial Regulation and Central Bank Policy
    Published online:
    06 August 2018
    Print publication:
    06 October 2017, pp 57-74

  • Summary

    Introduction

    The financial system is a component of the country's financial and monetary regime. The financial system consists of markets and institutions designed to transfer funds from lenders to borrowers through two channels: direct finance and indirect finance.

    Funds transferred through markets constitute direct finance and account for about 30 percent of the flow of funds in the United States. There are two types of financial markets: money markets, which deal in financial instruments with a maturity up to one year, and capital markets, which deal in financial instruments with a maturity greater than one year. Despite the fact that the financial markets represent only about 30 percent of the flow of funds, they are the foundation of the entire financial system. Interest rates are determined in the financial markets directly between lenders and borrowers; financial markets provide liquidity to the rest of the financial system and economy; and some financialmarkets come about as close to the model of perfect competition as one can find in any economy, because they consist of large numbers of well-informed participants purchasing and selling a well-defined product.

    The majority of funds in the United States and in most countries, however, are transferred through financial institutions and referred to as indirect finance, and sometimes intermediation finance. Examples of financial institutions are banks, S&Ls, credit unions, insurance companies, pension funds and finance companies. Financial institutions provide not only the majority of financial needs of the economy but also financial services to a larger number of smaller lenders and borrowers than cannot be accommodated in direct financial markets. Direct financial markets support the borrowing needs of large businesses and government, while indirect finance supports the borrowing needs of large and small businesses alike as well as virtually all consumer and mortgage credit needs.

    Financial markets and institutions both transfer funds but are considered separately because they represent two distinctly different channels of finance, even though they have important interactions between each other. These interactions have increased dramatically since the 1970s, when deregulation and liberalization of the financial system became an ongoing process.

    Financial markets are, essentially, electronic meeting places for lenders and borrowers rather than the usual “bricks and mortar” financial institutions most people think of as the financial system. Financial markets have no ongoing balance sheet.

  • 13 - Step 2: The Tools of Monetary Policy; and Step 3: Monetary Policy Instruments

  • from Part IV - Five Steps to Understanding Central Banks and Central Bank Policy
  • Thomas F. Cargill, University of Nevada, Reno
  • Book:
    The Financial System, Financial Regulation and Central Bank Policy
    Published online:
    06 August 2018
    Print publication:
    06 October 2017, pp 279-293

  • Summary

    Introduction

    As part of the sequence of central bank policy, in Step 2 the central banks are seen to possess a set of tools used to influence base money, the money supply, credit and interest rates, and thereby influence general economic activity. The basic tools of monetary policy are the same for virtually all central banks. The tools of monetary policy are like the tool set used by a mechanic in an automobile repair shop. The mechanic knows how he/she wants to adjust the engine to improve performance (final target), but without a set of wrenches, sockets, electronic and other types of tools there is no way the intentions of the mechanic can be realized. Like the mechanic, central banks have a basic set of tools they apply to the financial sector, which, in turn, influences the overall economy.

    The tools of monetary policy are directed to influence a policy instrument (Step 3), which in turn influences economic activity (Step 4), which in turn is designed to achieve the final policy target or targets (Step 5). There are two categories of policy instruments: first, measures of the money supply; and, second, key interest rates. Measures of the money supply are a quantity variable and include base money (the monetary base or high-poweredmoney) and various measures of the money supply, such as M1, M2, etc. The key interest rate is a price variable, and is the interbank interest rate or the federal funds interest rate in the United States.

    This chapter discusses the tools of monetary policy, issues regarding the choice of policy instrument, and the policy instruments used by the Federal Reserve.

    The Tools of Monetary Policy and the Decline of Selective Tools

    The tools of monetary policy are divided into three categories: general tools, selective tools and announcement tools, or what the Federal Reserve once referred to as “moral suasion”, more recently referred to as “forward guidance”.

    The general tools are designed to influence the overall supply of loanable funds to the economy while the selective tools, in contrast, are designed to influence the supply of loanable funds to specific sectors of the economy. That is, the general tools are focused on the overall supply of credit, permitting the market to allocate the overall supply of credit, while the selective tools are focused on the allocation of credit determined by the central bank.

  • International Mortality and Longevity Symposium

  • Journal:
    British Actuarial Journal / Volume 22 / Issue 3 / September 2017
    Published online by Cambridge University Press:
    04 October 2017, pp. 469-489
    • Article
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  • 1 - Introduction

  • from Part–I - Introduction
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 3-20

  • Summary

    In the early 1980s, the word ‘derivative’ was used mainly in chemistry (as in, hydrocarbon derivatives) or mathematics (as in, the second derivative of a function). Today, it is most commonly used in the context of financial markets. This is a reflection of the phenomenal speed with which these new financial instruments have evolved. Derivative markets today have an estimated value of over 378 crore crores or 3.78 x 1016. To put this figure in perspective, it is several times larger than the whole world's Gross Domestic Product (GDP)! Once considered exotic instruments used only by the high priests of international finance, these have now become ubiquitous. More and more companies and even some governments are using, or being forced to use, derivatives in a fast-changing world of unprecedented opportunities and unprecedented risks. An understanding of derivatives is thus a necessity for anyone interested in the financial markets.

    Definition of derivative

    A derivative security (commonly shortened to derivative) is a security or contract designed in such a way that its price or value is derived from the price of an underlying asset.

    For instance, the price of gold ‘futures contracts for October maturity’ is derived from the price of gold. The value of a ‘September call option’ on sugar is derived from the price of sugar. The value of a ‘five year interest rate swap’ is derived from the prevailing rate of interest. The price of a derivative security is not arbitrary; it is linked to the price of the underlying asset. A rise in the price of the underlying may lead to a rise (or fall) in the price of the derivative, but in a predictable way. Because the relationship is predictable, transactions in derivatives can be used as a method to compensate for, or offset, the risk of price changes in the underlying asset. Formulae can usually be used to calculate the effect of the price of the underlying in the price of the derivative. However, the relationship is not always precise and the formulae are not always accurate and hence derivatives may not always work exactly as intended.

  • 5 - Interest Rate Futures

  • from Part–II - Forwards and Futures
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 88-112

  • Summary

    As discussed in the introduction, interest rates have become quite volatile in the modern era. Changes may occur either because of policy action by the central bank or because of changes in the money market triggered by macro-economic changes in the domestic market, or even because of fluctuations in the foreign exchange market. Whatever the cause, institutions and individuals who borrow or lend significant sums, especially those who borrow or lend at floating interest rates, are exposed to risks arising from fluctuations in interest rates. Interest rate futures are an instrument allowing hedging and speculation in these risks. Interest rate futures are a sub-set of interest rate derivatives.

    Interest rate futures or debt instrument futures

    Strictly, interest rate futures are not futures contracts on interest rates per se, but rather futures contracts on underlying interest-bearing debt instruments like corporate, government and other bonds or short term deposits with a pre-specified face value and coupon (i.e., interest rate). When the maturity value of a bond or deposit is known, the implicit rate of interest (yield) can be calculated.

    The underlying can be either a short term debt instrument (like a bank deposit) or a long term debt instrument (like a bond or debenture). Therefore, a futures contract on a debt instrument is ipso facto a futures contract on interest rates, but the relationship is inverse. This is different from stock or commodity futures: when one talks about these terms, one knows that one is substantially and directly dealing with the price movement in the stock and/or commodity itself, and not some implicit number therein.

    The price in its own domestic market of a sovereign (i.e., central or federal) government security denominated in local currency varies exclusively and inversely on the basis of interest rates because credit and liquidity risks are nil. The coupon rate of interest on a bond reflects the rate of interest prevailing at the time the bond was initially issued, but interest rates change over time.

  • 16 - Exchange Traded Funds and Structured Products

  • from Part–V - Other Derivatives and Derivative-like Instruments
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 241-254

  • Summary

    This chapter examines exchange traded funds (ETFs) and ‘structured products’. Some, but not all, ETFs and structured products are effectively derivatives.

    Exchange traded funds

    ETFs are investment funds that can be bought or sold on an exchange like a share. They may be of two types:

  • • ‘Index mutual funds’ or ‘Cash ETFs’ whose composition and performance matches a specified equity or other price index; such funds may hold the actual underlying asset in the same proportion as the index. For example, an ETF mirroring the Nifty index might hold the shares comprised in the Nifty in exactly those proportions; a gold ETF will hold gold. Cash ETFs may be geared up by borrowing.

  • • Synthetic funds whose performance matches a specified underlying without actual ownership of the underlying.

    • ETFs usually trade close to, but not exactly at, their Net Asset Value (NAV) although depending on demand and supply they can trade at significant premia/ discounts. The NAV is the value of the assets owned by the fund but the shares of the fund may trade at values higher or lower than that underlying value. To the extent the fund actually owns income-earning assets; ETFs may have a yield through dividends.

    Most ETFs have an annualised expense ratio – ranging from 0.1 per cent of the price or NAV to around 2 per cent, depending on the liquidity, quantity of assets under management and strategy. (A strategy requiring more frequent trading or ‘rolling over’ of underlying assets will require higher costs than one involving passive holding of a fixed set of assets.) In this respect, the cost of holding the index fund is different from an actual holding of the underlying.

    As with company shares, unless there is an Initial Public Offering (IPO) or Follow-on Public Offering (FPO), most trading takes place in the secondary market. Only some dealers buy ETF units in large blocks called ‘creation units’ directly from the ETF distributor.

  • 15 - Other Derivatives

  • from Part–V - Other Derivatives and Derivative-like Instruments
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 235-240

  • Summary

    The three main derivative securities (futures, swaps and options) have been discussed at length in preceding chapters. This chapter covers other derivatives, in brief. Analytically, many of these derivatives can also be viewed as being constructed from the basic building blocks of futures and options, an exception being event-based derivatives which are closer conceptually to insurance contracts.

    Forward rate agreements

    A forward rate agreement is a contract, generally entered into between a bank and a customer, which gives the latter a guaranteed future rate of interest to cover a specified sum of money over a specified period of time in the future. A forward rate agreement (FRA) does not involve actual lending or borrowing of sums of money. It is merely an agreement which fixes a rate of interest for a future transaction. At the time when the customer actually requires funds, he has to separately borrow the money in the cash market at the rate of interest prevailing then. If the rate of interest payable in the cash market turns out to be higher than the rate of interest fixed in the FRA (entered into earlier), the bank which signed the FRA will pay to the customer the difference in the interest rate. However, if the rate of interest payable in the cash market turns out to be lower than that fixed in the FRA, the customer has to pay the difference in the rate of interest. This transaction is known as purchase of a FRA from the bank.

    It is worth repeating that no actual lending or borrowing is involved in the FRA. If the customer eventually decides not to borrow the sum of money, no amount is payable from or to the bank. While reference was made to a customer intending to borrow, it is also possible for a customer to enter into an FRA for his deposits. A customer may wish to have a guaranteed rate of interest for a sum of money which he intends to deposit at a future point of time. He can enter into an FRA with a bank. He has to separately make a deposit in the cash market at the appropriate point of time.

  • 18 - Infrastructure for Derivatives Trading

  • from Part–VI - Accounting, Taxation and Regulatory Framework
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 282-292

  • Summary

    Derivatives can be traded on exchanges, or OTC. In principle, not much infrastructure is required for OTC trading – all it requires is for two parties to agree. Exchanges originated as informal below-the-tree marketplaces for hedging and speculating. In earlier days, an exchange was often merely a known marketplace in contrast to isolated one-on-one transactions, and did not afford one the counterparty protections of a modern clearing house. Nonetheless, the public and open nature of the transactions meant that the credibility and reputation of both parties were involved and this offered some protection against default.

    Exchanges are essentially the first layer of regulation for exchange-traded derivatives. Modern exchange trading generally reduces counter-party risks because the two parties are shielded from each other by the exchange's clearing houses, their margin requirements and regulatory safeguards. For example, A and B can decide on a wheat transaction for next year directly with each other (that would be a forward contract) or through an exchange (a ‘futures’ contract). In India, forward contracts in commodities outside an exchange are, unless intended for and closed by delivery, generally illegal. Since the financial crisis of 2008-09 there has been a global push towards promoting exchange-based trading above OTC trading (bringing it closer to the long-standing Indian position). The infrastructure requirements of an exchange and its various stakeholders are acquiring greater significance.

    Yet, non-exchange contracts will always remain, primarily because the standardised terms of exchange traded derivatives may not match the specific needs of certain hedgers. The biggest advantage of OTC markets for participants is that terms can be customised.

    Apart from this ‘genuine’ reason for using OTC contracts, another motivation for treating contracts as OTC (even when customisation is not needed) is regulation. OTC contracts may be legal but exempted from the regulatory requirements applicable to exchange-traded transactions, in many countries. Therefore, large but semi-standardised ‘OTC’ markets have grown in certain countries and for certain instruments. Many of them use a large number of standardised terms agreed upon by industry participants. Such contracts, though nominally are over the counter, have exchange-like characteristics: they are OTCs for the purpose of avoiding government regulation, but in practice an informal ‘exchange’ or association works.

  • 19 - Regulation of Derivatives Trading: An Introduction

  • from Part–VI - Accounting, Taxation and Regulatory Framework
  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp 293-298

  • Summary

    W. R. Natu, a former Chairman of the Forward Markets Commission and one of the pioneer futures regulators in India summarised the need for regulation in the following words:

    The private interest of an operator can … be at considerable variance with the interest of the trade and public interest. It is because of this divergence that the need for regulation arises.

    While this was in relation to futures markets, it is applicable to derivatives generally. In addition to the need for regulation in order to secure the public interest, there is also another justification, at a more practical and down-to-earth level, for regulating derivatives. This arises in connection with such matters as which varieties of a particular commodity or financial instrument may be delivered against the futures market, where delivery can be given or taken, how price differences are to be fixed between one variety and another, etc. Generally, regulations on such matters are framed by the exchanges which operate futures markets, and the national regulatory authority does not come into the picture except in abnormal circumstances.

    Regulatory instruments

    The main instruments of regulation used by the regulatory authorities and/or governing bodies of individual markets for ensuring orderly trading, are the following:

  • a. Margin variation: As explained earlier in this book, margin is a proportion of the contract value which a buyer or seller in the futures market is required to put up against his transaction. The purpose of margin is to prevent defaults. The higher the margin the greater the amount of capital which is locked up against a particular transaction and, therefore, the higher the cost of the contract. Increase in margins is an inducement to reduce the volume of trading, and vice-versa. Increase in margin is generally resorted to when the regulatory authorities feel that there is an excess of speculative activity. On the other hand, decrease in margins is prescribed when it is felt that there is inadequate trading activity thus impairing liquidity of the market.

  • b. Imposition of special margins: Special margins, which are over and above the ordinary margins referred to in (i) above, are generally imposed on only one side of the market-place. For example, when it is felt that there is an excessive amount of speculative buying in the market, it may be decided to impose a special margin on buyers alone.

Derivatives
  • 2nd edition
  • T. V. Somanathan, V. Anantha Nageswaran, Harsh Gupta
  • Published online:
    02 August 2019
    Print publication:
    06 September 2017
  • This book provides a comprehensive but concise treatment of the subject of derivatives. It focuses on making essential concepts accessible to a wider audience. The book eschews complicated mathematics and high school level mathematics is sufficient to understand it. It describes and explains various derivative instruments, their use and pricing, and the functioning of derivative markets. It uses a large number of examples to elucidate concepts and illustrate their real-life application. A distinguishing feature of the book is that it goes beyond the narrow perspective of derivative traders and investors and takes a broader approach which enhances its appeal to a range of readers. This book will be useful for students in the fields of economics, econometrics, derivatives, and finance and financial professionals, bankers and investors.

  • Preface to the First Edition

  • T. V. Somanathan, V. Anantha Nageswaran, Singapore Management University, Harsh Gupta
  • Book:
    Derivatives
    Published online:
    02 August 2019
    Print publication:
    06 September 2017, pp xv-xvi

  • Summary

    As recently as 1985, futures trading was so obscure in India that even bankers, financial journalists and some professors of finance and economics would ask what it was. Discussions on the subject, with layman or professional alike, would almost always have to begin with a lengthy introduction.

    Today, awareness has increased. The gradual globalisation of the Indian economy means that Indian professionals and academics simply cannot afford to be unaware of futures and other derivatives, and their applications in India. Yet, there is no work of reference on the subject for the Indian reader to turn to. This book is a modest attempt to fill that gap.

    While covering the whole canvas, the book tries to address the specific needs of diverse groups of readers. For the professional and the student of finance, it provides a detailed study of the manner in which the markets work and how the knowledge can be used to make profits or avoid losses. For the academic and the student of economics, it surveys the theoretical literature, explains methods by which empirical studies can be performed and presents some of the findings of the author's empirical research on Indian futures markets. For the policymaker, regulator and government official, the book examines at length the larger public purpose of derivatives markets, covering the regulatory experience in India, comparing it with experience abroad and suggesting improvements. For the generalist manager, management accountant, internal auditor and board member of a corporate entity, it discusses at length the management of derivative exposures; a job which cannot be left entirely to the specialist (as the spate of expert-led derivative disasters has so painfully shown). For the financial accountant and external auditor, it provides a detailed overview of the accounting treatment of derivative transactions and the issues involved. For the tax practitioner, it examines the taxation of derivatives under the Income Tax Act.

    In a book of this nature, there is always a difficulty in balancing the needs of the practitioner with those of the academic. However, the author is hopeful that just the right balance has been struck. Issues primarily of academic interest have been placed in Appendices. Similarly, there is a difficult judgement to be exercised on the degree of complexity to which the text should go, since an attempt to meet the needs of the derivatives super-specialist would detract from the usefulness of the book to others.

Page 156 of 453